Using Vickrey auctions as a price discovery mechanism

by epiphi1 min read12th Jan 20201 comment

16

Economics
Frontpage

I recommend "Pricing niche products: Why sell a mechanical keyboard kit for $1,668?" for providing a practical case study in price dynamics that helped with my economic intuitions.

The author's friend had created a new custom keyboard kit. Their friend's previous kit had sold out in minutes, so clearly something was amiss with their "estimate costs and premiums and then set a price" approach:

I’m not a fan of this inside-out approach, for several reasons:

  • factors like “brand premium” are inherently subjective — the temptation to compare to others limits potential upside and differentiation
  • picking a (new, higher) price may have reputational downsides (because o_f course_ your customers spend all day in mechanical keyboard chat rooms and may gripe about you “selling out the community”)
  • you will second guess yourself regardless of the outcome; either you sell out again (goto 0) or you sell too few and then must live with the shame of having $20k worth of unsold keyboard in your garage

The most compelling argument against simply picking a price, though, is that it limits how much you can learn about your market.

Instead, they run a Vickrey auction (or "second-price sealed-bid auction") and find that the demand curve supports 3x the list price they would have chosen:

I can’t overstate the benefits of knowing the demand curve.

In my friend’s case, the auction let them sell far above their initial price and revealed that the market was deep enough to justify a larger production run.

(I discovered this post via The Prepared, a newsletter that I'd strongly recommend.)